mortgage lending analytics - whiting school of...
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Mortgage Lending AnalyticsOperational Practices
December 2, 2014Leslie Deich
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Today’s Agenda The basics of mortgage lending from both the
borrower and lender’s perspective Overview of the operational steps for
originating and servicing the loan Highlight areas that lend themselves to
analytical or model driven solution Provide a closer look at the loss mitigation
decisions
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Looking for a mortgage?
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Lender’sView of Loan “Life Cycle”
Marketing
OriginationBilling
Collection
Payment
ExitLoan Paid Off
ORLoan Defaults
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Decisions Across the Life Cycle
• How attract right customer?• How spend marketing $$?• What offer to make?• What price covers risk?
• Credit Policy Review• Prior experience with
customer?• Is this fraud?• Validity of property
valuation?
• Verification of contact details• Explore willingness to pay
electronically• And, with automatic withdrawal
• At what point to reach out to customer for missed payment?
• What media to use?• Is a reminder needed next month?• Is it time to discuss alternatives
paths to payment?• Should we modify the loan?• Should we Exit the loan? • How should we exit the loan?
Marketing
Origination Billing
Collection
Payment
ExitLoan Paid Off
ORLoan Defaults
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What is the basis for such decisions? Valuation of the Home
Expectation of Borrower Behavior
Expectation of Future Home Prices (exit options)
Expectation of Future Interest Rates (exit options)
Overall Economic Health- local, regional
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Loss Mitigation – The Decision Process
Borrower Stops Paying
the Loan
Do we modify the loan?
Do we exit without
foreclosing?
Do we foreclose on the house?
The Housing Crisis
Losses --
Home Prices --
Risks --
BeforeAfter
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Source: Mortgage Bankers Association / Haver Analytics
US Mortgage Foreclosure Inventory
-
500,000
1,000,000
1,500,000
2,000,000
2,500,000
1979
1980
1981
1982
1984
1985
1986
1987
1989
1990
1991
1992
1994
1995
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1999
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Loss Mitigation – Lifecycle of Defaulted Loan
Loan Referred To FC
L
Loan Stops Paying
Originate Loan
Property Sold (REO
)
FCL C
omplete
Loan Active Loan in Foreclosure House For Sale
For the decision to Modify the Loan or exit AND how to exit, what metric can we use?
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Loss Mitigation - Decision to Modify or Exit?
Performing MOD NPV PIt
(1)tt1
m
Non-Performing MOD NPV PIt
(1)tt1
6
PRr6
(1)r6
How will we measure the impact of our decision?
What is the question we are answering? • Is it better to Modify (MOD) or Exit the loan?
• Impact on Cash Flow (CF)
• Net Present Value (NPV) of the Change in CF over the remaining months (m) on the loan at a given discount rate (δ)
CF for a performing mod comes from? • Borrower makes monthly payments of Principle and Interest (PI)
If Loan Modification is successful, the Cash Flow from Principle and Interest will continue,
When is a modification successful? • Lets assume 6 months
(A)
(B)
What is the source of CF for an non-performing mod?
• Borrower makes some (?) monthly PI paymentPlus, proceeds from the sale of the house (PR)After some months (r) in the Exit process
What is probability the mod succeeds? • Probability of Default (PD)
Lets represent, - the remaining duration of the loan in months - Lets use δto represent the discount rate
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Loss Mitigation - Decision to Modify or Exit ?
YesMOD NPV PD B (1PD) A
NoMOD NPV PRr
(1)r
(1)
(II)
Performing MOD NPV PIt
(1)tt1
m
Non-Performing MOD NPV PIt
(1)tt1
6
PRr6
(1)r6
If Loan Modification is successful, the Cash Flow from Principle and Interest will continue,
(A)
(B)
Estimate the Cash Flow of a modified loan as,
And when the loan is not modified the Cash Flow can be represented as,
A loan is modified when (1) > (II)
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Loss Mitigation - Decision to foreclose or use alternative?
AltFCL NPV PRa
(1)a
FCL NPV PRb
(1)b
(III)
(IV)
What is the difference between these options?
What is the question we are answering? • Is it better FORCLOSE or use an ALTERNATIVE Exit strategy?
• TIME – Length of the Exit process
Let’s introduce notation, • a = time in alternative to FCL strategy• b = time it takes to exit thru FCL
If Exit thru Alternative to FCL strategy,
If Exit through FCL strategy,
A loan EXITS thru FCL when (1V) > (III)
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Loss MitigationFinal Step: Compare the Cash Flows
Defaulted Loan
Modify
ForeclosureAlternative to Foreclosure
Exit
If (1) > (II) If (1) < (II)
If (III) > (IV) If (III) < (IV)
AltFCL NPV PRa
(1)a
FCL NPV PRb
(1)b
(III)
(IV)
YesMOD NPV PD B (1PD) A
NoMOD NPV PRr
(1)r
(1)
(II)
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Key Take Aways
There are many opportunities to leverage analytical prowess in mortgage operations
Clearly state the question you are trying to address
Keep your solution tied to your objective
Don’t let limited historical data hold you back
Determine how you will measure your impact
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What’s Next?
How do you obtain “Executive Buy-in” for this new idea?
Link impact to bottom line Understand their tolerance for math
Remember – K.I.S.S.
8th Grade Math is About The Tolerance Level
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The Securitization Process
MortgageBank
Borrower Servicer Investors
Mortgage Security
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Source: Irrational Exuberance by Robert Shiller
Case-Shiller Historical Home Price Index(Real Prices)
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Components of Model Governance Program
1. Register All Models/Inventory
2. Model Validation Program
3. Model Performance Tracking
4. Change Management Process
5. Model Ownership
6. Roles & Responsibilities
7. Documentation
8. Model Usage Definition
9. Model Approval Process
10. Issue Tracking & Resolution
11. Model Governing “Authority”
Polices & Procedures for executing all of this…
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Success will be dependent upon….
Definition of “Model”
Clarity Around Business Process
Collaboration among Model Owner Model Users Model Validator
Transparency
Executive Sponsorship
Consequences for Lack of Adherence